CREDIT OPINION National Westminster Bank PLC Update following ratings' affirmation, outlook changed to positive Update Summary RATINGS National Westminster Bank PLC Domicile United Kingdom Long Term Debt (P)A2 Type Senior Unsec. Shelf Fgn Curr Outlook Not Assigned Long Term Deposit A1 Type LT Bank Deposits - Fgn Curr Outlook Positive Please see the ratings section at the end of this report for more information. The ratings and outlook shown reflect information as of the publication date. Contacts The long term issuer rating of National Westminster Bank Plc (NatWest Bank), The Royal Bank of Scotland plc (RBS; previously Adam & Company PLC) and Ulster Bank Limited (UBL) is A2 and their long-term deposit ratings is A1 with a positive outlook; their corresponding short-term debt and deposit ratings are Prime-1. We align the ratings of UBL with those of NatWest Bank because of the high level of integration between the two banks. The BCAs of baa1 for NatWest Bank, UBL and RBS -the group s ring fenced banks- reflect: (1) moderate asset risk, with legacy exposures mitigated by these banks predominantly retail and small business lending activities; (2) robust capitalisation and modest leverage; (3) good and stable profits from the retail and business banking activities, underpinned by the banks strong franchises; and (4) strong funding profile and ample liquidity of the ring-fenced subgroup. We view that, post 1 January 2019 UK ring-fencing implementation, the credit profile of NatWest Bank, UBL and RBS will strengthen, as they will be responsible for retail, SME and corporate lending activities in England, Scotland, Wales and Northern Ireland, and will have a largely deposit-based funding profile. The better asset profile of the ring-fenced banking entities is expected to result in more predictable and less volatile earnings relative to the group s non ring-fenced banking entities. Alessandro Roccati +44.20.7772.1603 Senior Vice President alessandro.roccati@moodys.com Credit strengths Aleksander Blacha +44.20.7772.5282 Associate Analyst aleksander.blacha@moodys.com» Good level of profitability could come under pressure due to Brexit and new competitors Laurie Mayers +44.20.7772.5582 Associate Managing Director laurie.mayers@moodys.com Nick Hill MD-Banking nick.hill@moodys.com +33.1.5330.1029» Capitalization to remain high» High level of retail and corporate deposit funding and sound liquidity» High volume of deposits resulting in two notches of loss-given failure uplift» Moderate probability of government support resulting in one notch uplift incorporated in senior ratings Credit challenges CLIENT SERVICES Americas 1-212-553-1653» Credit risk has largely improved but remains vulnerable to Brexit uncertainties Asia Pacific 852-3551-3077» Ongoing restructuring and conduct issues represent a tail risk Japan 81-3-5408-4100 EMEA 44-20-7772-5454
Rating outlook NatWest Bank s, UBL s and RBS s ratings outlook is positive. The positive outlook reflects our expectation that fundamentals will improve over the next eighteen months as the banks substantially complete their restructuring exercise enabling them to generate more stable and sustainable earnings. Factors that could lead to an upgrade» The baa1 BCAs of NatWest Bank, UBL and RBS could be upgraded if the banks were to substantially complete their restructuring, their asset risk profiles were to improve materially, and/or if profitability were to improve significantly. An upgrade of NatWest Bank s long-term senior unsecured debt and deposit ratings and UBL s and RBS's long-term deposit ratings could also result from a higher-than-expected stock of more junior bail-in-able liabilities at the ring-fenced sub-group that would provide greater protection for the bank s junior depositors. Factors that could lead to a downgrade» The baa1 BCAs of NatWest Bank, UBL and RBS could be downgraded in the event of: (1) a deterioration in operating conditions in the UK, beyond Moody s current expectations, leading to higher asset risk and lower profitability; (2) a decline in capitalisation; (3) large losses from their books from legacy assets; (4) a material weakening of the sub-group s liquidity profile; or (5) a weakening of the intra-group capital and liquidity support mechanisms. The ratings could also be downgraded due to a reduction in the stock of bail-in-able liabilities that would reduce the degree of protection for senior creditors. Key indicators Exhibit 1 National Westminster Bank PLC (Consolidated Financials) [1] Total Assets (GBP billion) Total Assets (EUR billion) Total Assets (USD billion) Tangible Common Equity (GBP billion) Tangible Common Equity (EUR billion) Tangible Common Equity (USD billion) Problem Loans / Gross Loans (%) Tangible Common Equity / Risk Weighted Assets (%) Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%) Net Interest Margin (%) PPI / Average RWA (%) Net Income / Tangible Assets (%) Cost / Income Ratio (%) Market Funds / Tangible Banking Assets (%) Liquid Banking Assets / Tangible Banking Assets (%) Gross Loans / Due to Customers (%) 12-172 12-162 12-152 12-142 339 382 458 16 18 21 0.9 27.8 10.4 1.8 4.7 0.8 61.2 16.4 34.7 82.8 314 368 388 15 17 18 1.1 23.0 12.0 1.6 2.0 1.9 78.3 12.3 35.6 76.9 301 408 443 14 19 20 4.4 22.4 39.7 1.5-2.5-0.5 126.5 12.6 41.1 76.4 307 396 479 14 18 22 10.6 20.8 67.2 1.3 1.4 1.8 83.0 13.4 43.4 76.9 12-133 CAGR/Avg.4 352 423 582 11 13 18 13.1 9.3 82.5 1.1-1.2-1.5 120.2 21.9 49.9 75.6-0.95-2.55-5.85 9.85 8.05 4.45 6.16 23.57 42.46 1.56 1.47 0.56 93.96 15.36 40.96 77.76 [1] All figures and ratios are adjusted using Moody's standard adjustments [2] Basel III - fully-loaded or transitional phase-in; IFRS [3] Basel II; IFRS [4] May include rounding differences due to scale of reported amounts [5] Compound Annual Growth Rate (%) based on time period presented for the latest accounting regime [6] Simple average of periods presented for the latest accounting regime. [7] Simple average of Basel III periods presented Source: Moody's Financial Metrics This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history. 2
Profile The ring-fenced bank sub-group will include National Westminster Bank Plc (NatWest Bank), Ulster Bank Limited (UBL), The Royal Bank of Scotland plc (RBS; previously Adam and Company PLC), Coutts & Company (unrated), which will carry out most of its Personal & Business Banking and Commercial & Private Banking activities across England, Scotland and Wales and Ulster Bank Ireland DAC (long-term deposits Baa1 stable), which will carry out retail & commercial banking activities in the Republic of Ireland (A2 stable) NatWest Bank, the largest ring-fenced bank in the ring-fenced sub group, will have a stronger credit profile as it will retain mostly retail and SME activities, and have a more deposit-based funding profile. NatWest Markets Plc (NatWest Markets; previously The Royal Bank of Scotland plc) will retain RBSG's capital market activities. RBS International (RBSI; unrated) will retain mostly retail and commercial activities in the UK's Crown Dependencies. NatWest Markets will have a significantly weaker credit profile as it will become the entity of the group retaining capital markets and wholesale activities. As such, it will be largely market funded, have a sizeable trading and repo book, and will provide broker-dealer capabilities. Exhibit 2 Previous and proposed simplified legal entities group structure Source: Moody s Investors Service on Company data Detailed credit considerations Credit risk has largely improved but remains vulnerable to Brexit uncertainties The main risk for NatWest Bank is credit risk and relates to its 192 billion loan book at end-2017. Asset quality steadily improved in recent years: the problem loans/ gross loans ratio was 0.9% at end-2017 from 1.2% at end-2016 and 4.5% at end-2015. NatWest Bank's operating environment is heavily influenced by the UK and its Macro Profile is currently Strong+. The bank benefits from operating in a wealthy and developed country with a very high degree of economic, institutional and government financial strength as well as a low susceptibility to event risk. The main risks to the system now stem from the economic uncertainty resulting from Brexit and the high level of indebtedness of UK households, which are sensitive to changes in interest rates. Our assigned Asset Risk score of a3 reflects the strong improvement NatWest Bank has achieved in credit quality due to the reduction in non-performing loans and legacy assets and in sector and concentration risks. 3
Ongoing restructuring and conduct issues represent a tail risk NatWest Bank, RBS and UBL are currently undergoing a structural reorganization of their business model. The banks budget growth in mortgage lending and selected business segments; higher efficiency through both higher revenues and lower costs; and improved capital efficiency. We reflect the complexity of these entities multi-year restructuring program, the high level of operational risk associated with the execution of its restructuring, including structural reform in a one-notch negative adjustment for Corporate Behaviour, in the qualitative section of the BCA scorecards of NatWest Bank, RBS and UBL. Capitalization to remain high NatWest Bank shows one of the highest capital ratios among domestic and international peers: at end- 2017, it reported a UK Prudential Regulation Authority (PRA) transitional basis Common Equity Tier 1 (CET1) ratio of 23.5% and a Tier 1 leverage ratio of 6.2%, which is well above the UK Prudential Regulation Authority's current 3% requirement. We expect the CET1 capital ratio to decrease in the next eighteen months, due to restructuring, but to remain well in excess of the >13% management target. Our assigned capital score of a1 reflects the above trend. Good level of profitability could come under pressure due to Brexit and new competitors Retail and commercial and large corporate activities provide good levels of underlying profitability. In 2017, NatWest Bank reported a net income of 2.1 billion, compared with a net income loss of 867 million in 2016, mainly driven by higher income, lower loss from discontinued operations and lower litigation and conduct costs. Exhibit 3 NatWest Bank reported solid operating profits in 2017 Source: Moody's Investor Service on Company Data We view that the current good level of profitability of NatWest Bank s could come under pressure due to on-going pressure in the mortgage market, uncertainty leading up to Brexit and competition from new digitally-enabled competitors. We expect that Brexit will pressure NatWest Bank s revenues, cost of credit and profitability metrics due to heightened uncertainty over the UK s future trade relationship with the EU, leading to lower economic growth, reduced demand for credit, a modest increase in unemployment, downward pressure on property prices and potentially higher and more volatile wholesale funding costs. NatWest Bank s push to leverage new digital and cloud based solutions should result in improved IT resilience; increased automation in retail and business loans; and higher use of mobile banking for personal, business and commercial customers. The assigned baa2 profitability score, reflects the good profitability level of the bank, with a return on tangible assets of 0.7%. High level of retail and corporate deposit funding and sound liquidity In line with other similar retail and commercial players, NatWest Bank has a large level of stable retail deposits: its loans to deposit ratio was 82% at the end of 2017. In addition, the bank borrowed 17 billion of funding under the Bank of England s Term Funding Scheme at end-2017 which will have to be replaced over the next few years with either deposit or secured funding. NatWest Bank manages liquidity for the ring-fenced banks (RFBs) sub-group: we refer to RFBs sub-group funding and liquidity position for the calculation of our ratios. We reflect the solid funding and liquidity positions in a funding score of a2 and a liquid resources score of baa1 and an overall liquidity score of a3. 4
Support and structural considerations High volume of deposits resulting in two notches of loss-given failure uplift We apply our advanced Loss Given Failure (LGF) analysis to NatWest Bank, UBL and RBS as they are domiciled in the UK, which we consider as an operational resolution regime, following the implementation of the EU Bank Resolution and Recovery Directive (BRRD). Our standard assumptions assume: (1) residual tangible common equity at failure of 3% of tangible banking assets, (2) losses postfailure of 8% of tangible banking assets, (3) junior wholesale deposits accounting for 26% of the bank's total deposit book, (4) a 25% run-off in junior wholesale deposits, (5) a 5% run-off in preferred deposits, and (6) a 25% probability of deposits being preferred to senior unsecured debt. We consider the perimeter of the RFB sub-group for NatWest, UBI and RBS, as we deem this to be the resolution perimeter adopted by the regulator. For NatWest Bank, UBL and RBS, our LGF analysis results in a two-notch uplift for deposits and a one-notch uplift for senior unsecured debt from the banks s adjusted BCA. For junior debt our LGF analysis results in a high level of loss-given-failure, given the small volume of debt and limited protection from more subordinated instruments and residual equity. Government Support We expect a moderate probability of government support for NatWest Bank s senior unsecured debt and deposits and Counterparty Risk Assessment and for UBL s and RBS s deposits and Counterparty Risk Assessment, resulting in a one-notch uplift. For other junior securities, we continue to apply a low government support assumption resulting in no uplift. Counterparty Risk (CR) Assessment Counterparty Risk Assessments (CR Assessments) are opinions of how counterparty obligations are likely to be treated if a bank fails and are distinct from debt and deposit ratings in that they (1) consider only the risk of default rather than both the likelihood of default and the expected financial loss suffered in the event of default, and (2) apply to counterparty obligations and contractual commitments rather than debt or deposit instruments. The CR Assessment is an opinion of the counterparty risk related to a bank's covered bonds, contractual performance obligations (servicing), derivatives (for example, swaps), letters of credit, guarantees and liquidity facilities. The CR Assessment of NatWest Bank, UBL and RBS is positioned at Aa3(cr)/P-1(cr) The CR Assessment, prior to government support, is positioned three notches above the banks' adjusted BCAs of baa1. The uplift results from the buffer against default provided to the operating obligations by substantial bail-in-able debt and deposits. The CR Assessment benefits from one notch of government support. Counterparty Risk Ratings (CRR) Counterparty Risk Ratings (CRRs) are opinions on the ability of entities to honour the uncollateralised portion of non-debt counterparty financial liabilities (CRR liabilities) and also reflect the expected financial losses in the event that such liabilities are not honoured. CRR liabilities typically relate to transactions with unrelated parties. Examples of CRR liabilities include the uncollateralised portion of payables arising from derivative transactions and the uncollateralised portion of liabilities under sale and repurchase agreements. CRRs are not applicable to funding commitments or other obligations associated with covered bonds, letters of credit, guarantees, servicer and trustee obligations, and other similar obligations that arise from a bank performing its essential operating functions. The CRR of NatWest Bank, UBL and RBS is positioned at Aa3/P-1. The CRR is three notches above the banks' standalone BCAs of baa1. The uplift derives from the buffer against default provided to the operating obligations by substantial bail-in-able debt and deposits. Although NatWest Bank, UBL and RBS are likely to have more than a nominal volume of CRR liabilities at failure, this has no impact on the CRRs because the significant level of subordination below the CRR liabilities at the bank already provides the maximum amount of uplift under our rating methodology. The CRR also benefits from one notch of government support. 5
Ratings Exhibit 4 Category NATIONAL WESTMINSTER BANK PLC Outlook Counterparty Risk Rating Bank Deposits Baseline Credit Assessment Adjusted Baseline Credit Assessment Counterparty Risk Assessment Issuer Rating Senior Unsecured Shelf Subordinate -Dom Curr Jr Subordinate Pref. Stock Non-cumulative -Dom Curr Preference Shelf Commercial Paper Moody's Rating Positive Aa3/P-1 A1/P-1 baa1 baa1 Aa3(cr)/P-1(cr) A2 (P)A2 Baa2 Baa3 (hyb) Ba1 (hyb) (P)Baa3 P-1 ULT PARENT: THE ROYAL BANK OF SCOTLAND GROUP PLC Outlook Baseline Credit Assessment Adjusted Baseline Credit Assessment Senior Unsecured Subordinate Jr Subordinate Pref. Stock Non-cumulative Pref. Shelf Non-cumulative Commercial Paper Other Short Term Positive baa2 baa2 Baa2 Baa3 Ba1 (hyb) Ba2 (hyb) (P)Ba2 P-2 (P)P-2 Source: Moody's Investors Service 6
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CLIENT SERVICES 8 Americas 1-212-553-1653 Asia Pacific 852-3551-3077 Japan 81-3-5408-4100 EMEA 44-20-7772-5454